Some See Pres. Bush's Proposed Retirement Accounts as End to Traditional IRAs, Credit Unions Wait and See

WASHINGTON – The recently-proposed retirement accounts by Pres. Bush aim to eliminate the bowl of “confusing alphabet soup” and the “endless maze of confusing rules,” the U.S. Treasury touted shortly after the president’s proposals were made in January. At issue are the creation of several new accounts that do away with limitations on age and income status and allow for converting existing accounts into the proposed accounts “in order to consolidate and simplify savings.” While the proposals are less than a month old, credit unions would do better to focus on the existing accounts since Bush’s proposals could be revamped along the way, taking on different forms should they be implemented, said Karen Yandell Buege, CUNA Mutual Group’s individual retirement account training manager. “They’re quite sweeping,” Yandell Buege said. “The point is not to forget to make contributions to the accounts in place now. Awareness is very important and we’re at the very beginning stages of the proposals. There is some concern that the new proposal would do away with the traditional IRA, but right now it is the most common form of (retirement savings vehicle) and we wouldn’t want to see investors stop making contributions.” Indeed, the “bold new accounts will give more hardworking Americans the chance to save so they can enrich their lives and strengthen their retirement security,” said Treasury Assistant Secretary for Tax Policy Pam Olson. “They make saving simple for everyone and for every purpose. The two simple accounts will have one powerful goal – making saving for everyday life and retirement security easier and more attractive.” The three new accounts are lifetime savings accounts (LSAs), retirement savings accounts (RSAs) and employer retirement savings accounts (ERSAs). Here’s a look at the proposed accounts: The new LSA will allow an individual, regardless of age or income, to contribute $7,500 a year and make penalty free withdrawals at any time, with no holding period. Like current Roth IRAs, contributions will not be deductible but earnings and distributions will be tax-free. Unlike current education accounts and medical savings accounts, with LSAs, taxpayers will not need to carefully anticipate future qualified expenses and allocate savings among tax-preferred accounts. Taxpayers will not be required to document qualified expenses, financial institutions will not need to explain complicated rules to participants, and the government will not need to verify the qualifying expenses. Prior to Jan. 1, 2004, individuals may convert balances in an Archer Medical Savings Account, Coverdell Education Savings Account, and Qualified State Tuition Plan to LSAs. Balances in these accounts may not be converted to LSAs after 2003. The $7,500 contribution limit will be indexed for inflation in future years. The LSAs can be used for any type of saving, Bush said, adding “(they) will help millions of Americans save in one tax favored account for any purpose, including their children’s education, a new home, healthcare needs, or to start their own business.” He anticipates more low and moderate-income taxpayers will participate, stating many do not participate now because they are more likely to face a penalty if they need the funds. Knowing they can access the money at any time for any purpose will encourage them to set money aside and allow them to receive tax-free earnings from their first dollar of savings, he said. Bush also believes the LSA “takes away the hassle factor.” “The combination of universal eligibility and unrestricted tax-free withdrawals greatly simplifies the whole process, making it more likely that average taxpayers will participate, especially inexperienced savers. Many low- and moderate-income taxpayers will conveniently be able to put all their financial assets in one place; this will greatly simplify their taxes because they will no longer receive taxable investment earnings.” The LSA, counterpart, the RSA, can be used only for retirement saving. The new RSA aims to “improve and simplify” savings opportunities for all Americans by consolidating traditional IRAs, nondeductible IRAs and Roth IRAs, each of which has a “confusing and different set of rules” regarding eligibility and tax treatment, into one streamlined type of account with rules similar to current law Roth IRAs. Up to $7,500 (in addition to amounts contributed to an LSA) could be contributed to an RSA. Like current Roth IRAs, contributions will not be deductible but earnings will accumulate tax free and distributions after age 58 (or death or disability) will be tax free. Existing Roth IRAs will be unaffected (except that they will be renamed RSAs). Existing traditional and nondeductible IRAs may be converted into RSAs; those not converted to RSAs could not accept any new contributions (other than rollover contributions); no one would be required to convert. The $7,500 contribution limit will be indexed for inflation in future years. Bush cites “complex eligibility restrictions for IRAs under current law” as confusing for some taxpayers, causing some to avoid contributing to IRAs, even if they are eligible to contribute. IRA income limits were imposed in 1986 greatly limiting eligibility. Studies have shown that participation after 1986 fell among lower-income taxpayers, even among those still eligible to make deductible contributions. The incentive behind RSA are the repealing of the income limits that will eliminate the “confusion and complexity” associated with determining eligibility. Likewise, individuals will not be required to make minimum distributions from the accounts during their lifetime, simplifying financial planning in retirement. While current IRAs allow for withdrawals for many non-retirement purposes, each withdrawal from an IRA potentially reduces retirement funds. The goal of having a separate retirement account will help individuals plan for both non-retirement and retirement needs, Bush said. Finally, the employer retirement savings accounts (ERSA) are currently multiple tax-preferred, employer-based retirement savings accounts with similar goals but different rules regulating eligibility, contribution limits, tax treatment, and withdrawal restrictions. The budget proposal will consolidate 401(k), thrift, 403(b), and governmental 457 plans as well as SARSEPs and SIMPLE IRAs into a streamlined and simpler account, which can be sponsored by any employer. ERSAs will follow the existing rules for 401(k) plans, but these rules will be “greatly simplified”. For example, both the definition of compensation and the minimum coverage requirement will be simplified and the “top heavy” rules will be repealed. Nondiscrimination requirements for ERSA contributions will be satisfied by a single test and many firms may choose to adopt a new designed-based safe harbor to avoid this test altogether. The proposal simplifies qualification requirements while maintaining their intent of providing broad-based coverage of employees. By reducing unnecessary complexity, the proposal significantly reduces employer compliance costs, Bush touts. Complexity and the associated compliance costs are often cited as reasons that the coverage rate under an employer retirement plan has not grown above about 50% overall, and has remained under 25% among employees of small firms, Treasury noted. Firms that are currently not offering retirement plans because of compliance costs will be more likely to offer such plans under the proposal, increasing coverage and participation, Bush believes. Additionally, more small businesses will be able to cover more workers. The reduction in red tape will remove a barrier that discourages small business owners from offering this benefit to their employees. Small businesses employ about two-fifths of American workers, but the pension coverage rate has consistently remained under 25% among employees of small firms. Employees will benefit because firms currently offering employer plans will have reduced compliance costs, Bush proposed. “This is especially true of small employers who together employ about 4 out of every 10 American workers,” Olson pointed out. “It’s one important reason why only 50 percent of working Americans have any pension plan at all. I’m confident that simpler rules will encourage employers to create new plans for their employees because creating a qualified plan will be much easier.” Still, critics are skeptical about how much easier the accounts will be. “If all of this passes or even some of it makes it into law – and it does seem likely – then there will be all sorts of transition rules, grandfather rules, distribution rules for the new accounts and estate planning opportunities to explore with these new tax free retirement accounts,” said Ed Slott, a CPA and author of Ed Slott’s IRA Advisor. “With all the expected buildup, it is likely that much of this wealth will not be spent during the account owner’s lifetime and that will present new estate planning options on how to deal with these accounts when they are inherited.” -